Actually, I don't think this is System.IO limitation. It is general OS limitation which has been around since forever :-) MAX_PATH is declared as 260 characters in windows.h.
Would have been nice if VS.NET *told* me that that was the problem though, wouldn't it?
I had this same problem with a corrupted .Net compiler using VS.NET 2002 and the 1.0 framework. I downloaded and reinstalled the SDK 1.0a and it fixed the problem immediately. Remember to reboot.